Market Failure - Limiting pollution

Table of Contents

1. Topic pack - Microeconomics - introduction
2. 1.1 Competitive Markets: Demand and Supply
3. 1.1 Competitive Markets: Demand and Supply - notes
4. 1.1 Competitive markets - questions
5. 1.1 Competitive markets - simulations and activities
6. 1.2 Elasticities
7. 1.2 Elasticities - notes
8. Section 1.2 Elasticities - questions
9. Section 1.2 Elasticities - simulations and activities
10. 1.3 Government intervention
11. 1.3 Government Intervention - notes
12. 1.3 Government intervention - questions
13. 1.3 Government intervention - simulations and activities
14. 1.4 Market failure
15. 1.4 Market failure - notes
    1. The meaning of externalities
    2. Types of externalities
    3. How do externalities affect allocative efficiency?
    4. Negative externalities of production
    5. Negative externalities of consumption
    6. The economic theory of traffic congestion
    7. Demerit goods
    8. Government responses - demerit goods
    9. Possible government responses to externalities
    10. Direct government provision
    11. Extension of property rights
    12. Taxes and subsidies
    13. Tradeable pollution rights
    14. Regulation, legislation and direct controls
    15. Positive externalities of production
    16. Positive externalities of consumption
    17. Merit goods
    18. Why might merit goods be underprovided by the market?
    19. Government responses - merit goods
    20. Public goods
    21. Common access resources & sustainability
    22. The tragedy of the Commons
    23. Common access resources in practice
    24. Sustainability
    25. Threats to Sustainability
    26. The threat to sustainability from the use of fossil fuels
    27. The threat to sustainability from poverty
    28. Government responses to threats to sustainability
    29. Cap and Trade Schemes
    30. Promoting Clean Technologies
    31. The 'dirty side' of cleaner technologies
    32. International responses to threats to sustainability
    33. Asymmetric information
    34. Abuse of monopoly power
    35. Inequality
16. Section 1.4 Market failure - questions
17. Section 1.4 Market failure - simulations and activities
18. 1.5 Theory of the firm
19. 1.5 Theory of the firm - notes (HL only)
20. Section 1.5 Theory of the firm - questions
21. Section 1.5 Theory of the firm - simulations and activities
22. Print View

Tradeable pollution rights

Like the use of taxes and subsidies, tradeable pollution rights (otherwise known as tradeable emission allowances or permits), represent another market-based solution to the problem of negative externalities, in particular pollution.

They were first introduced in the USA in 1990 under the Clean Air Act in which the Environmental Protection Agency set a target rate of reduction for power stations' emissions of sulphur dioxide. Initially, power stations were issued with emission permits in proportion to their current pollution levels and were allowed to discharge pollution into the air up to a specified limit.

Thereafter, those power stations for whom the cost of reducing pollution was low, could sell their spare pollution permits to generators for whom the cost of pollution abatement, through the installation of appropriate equipment, would be very high. Thus, a market in tradeable pollution rights is created, stimulating pollution reduction through the possibility of making money out of selling surplus permits.

The main argument in favour of such a scheme is that it operates through the market via the price system: firms are given a profit incentive, through the right to sell spare permits, to find cheap ways of reducing their pollution levels. Such a system should be administratively cheap and simple to implement , as the regulatory agency need have no information regarding firms' costs - it simply has to issue the permits and arrange for their sale. In addition, consumers may benefit if the extra profits made by low pollution power stations, are passed on in the form of lower prices.

The main argument against the use of tradeable emission permits is that they do not actually stop firms from polluting the environment; they only provide an incentive to so - where a degree of monopoly power and relatively inelastic demand exist, the extra cost of purchasing additional permits so as to further pollute the atmosphere, could easily be offset by the possibility of charging consumers higher prices; moreover, the system of allocating permits in accordance to existing emission levels could be seen as a reward for the greatest polluters!